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Nye Lavalle
In Dealing With Bear Stearns,
Wall Street Plays Guardedly
March 13, 2008; Page C1
Wall Street has every interest in making sure that Bear Stearns Cos. is healthy. But hedge funds and traders also are trying to protect themselves.

Bear executives say that they are in no danger of a cash crunch and that the company's capital remains more than adequate. But in a sign of how skittish Wall Street has become in recent months, the New York investment bank is facing increasingly tough trading conditions.

Traders handling certain long-term transactions, such as credit-default swaps, said they are being extra cautious when Bear is the counterparty. In some cases, traders are seeking higher-ups' permission before acting.

In addition, some clients of rivals like Goldman Sachs Group Inc., Morgan Stanley, Credit Suisse Group and Deutsche Bank AG have asked those firms to be counterparties to Bear in completed transactions. Such a move frees clients from exposure in the event a firm can't cover its obligations on a trade.

Some hedge funds that use Bear as a prime broker also have been shifting portions of their business to other firms in recent weeks, according to hedge-fund managers and consultants who help pension funds and wealthy people choose where to place their money. A similar shift occurred last summer, but Bear soon recovered much of the lost business.

This week, the cost of a five-year policy to protect against default on $10 million of Bear's debt skyrocketed to a record of about $655,000 per year -- two or three times as much as for rivals, and up from around $300,000 two weeks ago. That cost declined yesterday to $580,000, according to data from Phoenix Partners Group. For Lehman Brothers Holdings Inc., the same coverage costs $365,000.

Tuesday, Bear shares sank to a five-year low even as the market rallied on news that the Federal Reserve would improve investment banks' access to liquidity. In 4 p.m. New York Stock Exchange composite trading yesterday, Bear fell $1.39, or 2.2%, to $61.58; it had traded up, hitting an intraday high of $67.82.

In an interview, Bear Chief Financial Officer Samuel Molinaro said there is no truth to speculation of deep trouble at the firm, which suffered the implosion of two mortgage hedge funds last summer. "We've been hearing rumors of all kinds of different issues surrounding our liquidity," he said.

Other securities firms, hedge funds and other investors said they are continuing to do trades with Bear. No hedge-fund clients serviced by Bear's prime-brokerage unit, which lends capital and facilitates trades, have been unable to redeem cash, Mr. Molinaro added.

Bear President and Chief Executive Alan Schwartz went on CNBC yesterday as a confidence-boosting measure. Mr. Schwartz said the effect of rocky market conditions is being exacerbated by baseless speculation. "Our balance sheet has not weakened at all," he said. Monday, Mr. Schwartz wrote in a release that the firm's "balance sheet, liquidity and capital remain strong." Since last summer, Bear has replaced much short-term funding with long-term funding.

According to Wall Street executives, Bear's fundamental issue isn't liquidity or capital as much as the erosion of its business model as a result of the credit crunch. Some traders and analysts, noting the lack of any proof that Bear actually faces a liquidity crisis, have been drawing comparisons to a similar period at Lehman in 1998. The rumor-mongering then nearly sparked a cash crunch.

"We know that firms on Wall Street, given the nature of the balance sheet and their need to constantly replace funding, can succumb to liquidity crises even if they're fundamentally solvent," said Merrill Lynch & Co. securities analyst Guy Moszkowski.

Still, some of Bear's counterparties are becoming increasingly cautious. At Deutsche Bank, some traders of credit-default swaps and other derivative securities are charging extra when Bear is the counterparty, according to people familiar with the situation.

Increasingly, these traders also are charging hedge-fund clients a fee for novations, or situations in which the fund asks Deutsche Bank to take its position as a counterparty to Bear on a particular transaction. One group of traders worked late Tuesday to review thousands of individual transactions in which Bear was the counterparty, said one person familiar with the situation.

A spokeswoman for Deutsche Bank declined to comment.

Novations occur frequently and for a variety of reasons, according to traders. During calmer times in the credit markets, approval for novations usually is handled by back offices or operations departments, said Mark Beeston, president of T-Zero, an electronic platform that helps dealers and money managers confirm derivative trades. Given the market's current volatility, it would be natural for higher-ranking risk managers to be much more involved in the consent process, he added.

Another standard situation that is becoming more ticklish is margin calls, people familiar with the matter say. Like any firm, Bear is experiencing its share of margin calls, which it works with counterparties to resolve.

Because of the heightened sensitivity, the mere existence of certain outstanding margin calls from Bear's creditors is being interpreted as a potential indicator of the firm's weakened condition, say traders and people familiar with Bear's positions. The value of Bear's current outstanding margin calls comes to far less than $1 billion, one of the people said.

According to Bear filings, at the close of the fiscal year in late November, the company had $11.1 billion in tangible equity, an important measure of its worth. Its gross leverage ratio, a gauge of the funds it has borrowed against its equity, is about 33 to 1. Goldman, with tangible equity of $42.7 billion, has a leverage ratio of 26 to 1, according to its filings.
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